There's such a thing as too trendy, in finance as in fashion. At its current price, Coach (ticker: COH) looks like a bargain and a better deal than its rival. It brings in 2½ times as much revenue—$5 billion in its most recent fiscal year to Kors' $2 billion—and has better operating profit margins. But investors deem Kors (KORS) the more fashionable of the two, so its enterprise value (market value adjusted for debt and cash) is nearly equal to that of Coach. Kors came public in December 2011 at $20; it closed on Friday at $59.11.

Investors worry that Coach, whose stock price has multiplied 20 times since 2000, to a split-adjusted $46.79, is at the end of a remarkable run. That fear seems overblown.

Coach commands a 28% share of the U.S handbag market. Not surprisingly, it has attracted a raft of competitors, including Kors with 9%.
Stuart Goldenberg for Barron's

There are three main concerns. First, high-end handbags are as lucrative as the latest smartphones and far easier to bring to market. Coach commands a 28% U.S. share. Not surprisingly, it has attracted a raft of competitors, including Kors, with 9% of the domestic market, Kate Spade, and Tory Burch. That was bound to cut into Coach's growth, and last quarter seemed to bring confirmation. Overall sales rose just 4% from a year earlier, and sales at longstanding North American stores slipped 2%. At Kors, sales grew a stunning 70%.

Second, women in recent years have spent a rising portion of their fashion budgets on accessories like handbags. That trend won't last forever.

And third, if Coach becomes too eager to boost sales growth it may increasingly turn to discounting. There's little sign now that margins are slipping, but the stock price seems to anticipate a decline in operating margins from 32% to the mid- to high-20s, says Brian Tunick, an analyst at JPMorgan Chase.

EVEN AS A SLOW-GROWTH COMPANY, Coach has some treats to offer stockholders. It generates free cash equal to more than 8% of its stock-market value. The stock has a 2.6% dividend yield, and the company boosted its payment 33% last year and 50% in 2011. (Management typically announces dividend increases in April, when reporting financial results for the fiscal third quarter, which runs through March.) Coach also spends plenty on share repurchases—$400 million over its past two quarters, or about 3% of its current market value.

And Coach may have more growth potential than investors believe. The shopper who visits one of its stores three years from now will see some important changes, says Lew Frankfort, Coach's chief executive and the architect of its long rise. Handbags will still play a prominent role, but there will be more shoes, clothing, and other items. "Coach will become a head-to-toe lifestyle brand rooted in accessories," says Frankfort.

A large portion of Coach's sales and profits come from factory-outlet stores, where it sells mostly items made for the stores based on discontinued designs. That has been a key advantage, because it allows the company to sell some goods at lower prices without alienating the fashion-forward crowd at its boutiques. And low rents make outlet stores more profitable than Coach's full-priced stores.

That said, the outlet shopper is more sensitive to economic effects, like this year's payroll-tax hike and the rising price of gasoline, which may help explain the disappointing North American sales last quarter. Frankfort calls the quarter "a moment in time" and not a harbinger. Wall Street expects companywide sales to increase 7% this fiscal year and 8% next year.

ASIA HOLDS PROMISE for both growth and profitability. Coach's China sales rose 40% last quarter, including double-digit growth at longstanding stores. The company is expected to expand square footage there by 35% this fiscal year. China's handbag and accessories market is larger than the U.S. market, and Coach's selling prices there are higher, but its China business isn't yet as profitable because marketing and distribution costs are still high relative to sales, says JPMorgan's Tunick. As the China business grows, its margins will rise, he says. Coach could also boost margins by buying out more of its foreign distributors, as it did last year in Korea. That results in a six- to nine-month hit to margins as it sells through the distributor's inventory, followed by a rise in margins as it sells directly to retailers.

A broad slowdown in U.S. accessories could crimp Coach's plans, but William Blair analyst Amy Noblin doesn't expect that to happen. U.S. wardrobes have become more fashionable in recent years, she says, resulting in faster clothing turnover. Customers have learned to look for discounts at private-label chains like H&M and Forever 21. A hot handbag design, on the other hand, can sell for years, with the designer changing only the texture and colors each year. That longer fashion life gives shoppers more confidence to pay up for bags. "You'll see a woman buying a $40 outfit at H&M, and then walking across the street for a $1,000 bag," says Noblin.

A key risk for Coach investors in coming years will be rising exposure to a fashion fail as it moves further beyond handbags. A low share price offsets that risk. Coach sells for 13 times this year's earnings forecast, a discount to the broad stock market. Kors fetches 32 times, perhaps a bit too fashion-forward even for fans of the brand. Michael Kors himself announced this past week he will sell three million of his shares, the latest in a string of sales. The company didn't respond to a request for comment. The sale will bring the founder's ownership to 2.4%. It was close to 12% before the company's initial public offering.

Tale of the Tape

While Michael Kors' profits are growing faster, Coach's shares are much cheaper, and it produces far more free cash.